Since 1986, the “Kiddie Tax” has been in place to close a loophole through which some taxpayers were getting investment income taxed at lower rates by transferring assets to their children. Under the rule between 1986 and 2017, unearned income (stock dividends, interest, and capital gains) gets separated out for any children in the family. If this unearned income exceeded a fairly low threshold, it was taxed not at the child’s low tax rate, but rather, at whatever marginal rate the parents were paying on their own income. That is, the child’s unearned income was “stacked” on top of the parents’ income. This effectively eliminated a substantial incentive to move assets, and the income they produced, to children.

Even with the Kiddie Tax in place, there were some small opportunities to use the child’s low bracket and standard deduction. For example, in 2017 the child’s standard deduction (for a child declared as a dependent on a parent’s return, and for a child with no earned income) was $1,050. And the Kiddie Tax threshold was an additional $1,050. So up to $2,100 of unearned income belonging to the child was tax-free, and any unearned income above that was taxed at the parents’ rates. With recent low interest rates, that could have been the interest on over $100,000 of fixed-income investments, or the dividends on a similarly large stock portfolio. But every penny of such income above that $2,100 threshold would be taxed at the marginal rate based on the income of the parents.

The new tax law has dramatically changed the old Kiddie Tax.

The Kiddie Tax remains, and the child’s standard deduction and the Kiddie Tax threshold both still remain at $1,050, so there is still no tax at all on a child’s unearned income of up to $2,100. However, the tax rate that applies to any income above that threshold is no longer the rate based on the parental income. Instead, the tax is based on the tax rates used for Estates and Trusts. This compressed tax schedule means that now there are some small low tax brackets to take advantage of. For children with substantial income, this will be a disadvantage, as the Estates and Trust tax schedule reaches the maximum tax rate of 37% at only $12,500. But it does introduce the opportunity to take advantage of the new lower brackets.

It’s going to be more important than ever to know how much unearned income your child’s investments are generating, and to manage it carefully to take advantage of that lowest bracket, as well as to avoid being pushed into the highest bracket, including avoiding the potential of having the child’s income taxed at a rate higher than that of the parents. If you have investments in your child’s name—such investments are often in an UTMA account—we encourage you to contact your financial and tax advisors as soon as possible and plan for these new rules.